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What Buffett Didn't Tell Goldman's CEO

Shortly after the SEC made public its fraud complaint against Goldman Sachs (NYSE: GS  ) , CEO Lloyd Blankfein contacted Warren Buffett to ask for advice. According to The Wall Street Journal, Buffett told Blankfein he'd get back to him if he came up with any good ideas. It strains credulity that the CEO of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , which stands to become Goldman's largest shareholder if it exercises its Goldman warrants, had nothing more to say. Here's why -- and what Buffett should have told Blankfein.

Buffett's been down that road
Buffett has a substantial economic interest in the matter, and he happens to be uniquely qualified to give advice. In 1991, Salomon Brothers was embroiled in of a Treasury-bond bid rigging scandal that brought the investment bank to the brink of bankruptcy. Buffett -- whose Berkshire owned a 14% stake in Salomon -- stepped in and steered the firm away from the precipice. The episode, described in Alice Schroeder's biography of Buffett, The Snowball, is a great case study in crisis management.

Always respect the person with a hand on your respirator
Buffett succeeded partly by adopting a conciliatory, even humble, tack in dealing with regulators, reasoning that the firm's fate ultimately lay in their hands. In fact, if the Treasury Department had followed through on its decision to bar Salomon Brothers from participating in Treasury security auctions, it would almost certainly have been a death blow for the bank. Buffett's demeanor contrasted sharply with the cavalier attitude Salomon's management had demonstrated during the mounting crisis.

Goldman's leadership could have learned this lesson earlier. Only in the last few days have managers been anything less than perfectly oblivious to popular and political anger in the aftermath of the credit crisis. Blankfein's "God's work" remark is either a stunningly effective quip, or an all-time classic of executive aloofness.

Laying his golden reputation on the line
At Salomon, Buffett also insisted on transparency with regard to regulators. He put his most highly prized asset – his personal reputation -- on the line to save the firm. On the Sunday on which the Treasury had scheduled a press conference to announce they would no longer do business with Salomon, Buffett made an emotional appeal to then-Treasury Secretary Nicholas Brady to reverse course. ("Nick, this is the most important day of my life," Buffett told Brady in a phone call.)

The settlement imperative
Perhaps Buffett's experience with Salomon was so traumatic that he can't bring himself to offer even a few pointers to Goldman. In that case, I'll step in for him.

"Settle as quickly as possible, and damn the cost!" That's what I would have told Blankfein, had he bothered to ask. It's very difficult to imagine a negotiated fine and related costs that would come anywhere near the reputational risk and uncertainty associated with a trial. Since the SEC announced its fraud complaint on April 15, Goldman Sachs has lost nearly a fifth of its market value -- $18.7 billion.

By contrast, a 2003 global settlement regarding conflicts between stock research and investment banking concluded with regulators imposing payments totaling $1.4 billion, spread across 10 firms. Salomon Smith Barney, now part of Citigroup (NYSE: C  ) , paid out the largest individual amount, at $400 million; Goldman's total came to $110 million. Goldman earned $13.4 billion in profits last year.

Goldman is starting to get it -- at last
Signaling that it recognizes the need to change the way it does business, Goldman has begun drawing up new guidelines dictating how employees can market securities to the firm's clients. This puts pressure on competitors, including Morgan Stanley (NYSE: MS  ) and JPMorgan Chase (NYSE: JPM  ) , to follow suit. It's also a show of goodwill, and part of the groundwork for a settlement with regulators. As far as the SEC's civil fraud charges are concerned, I'm highly confident they'll never reach trial. Lloyd Blankfein, who rose to prominence at Goldman within its trading activities, must surely realize that going to trial would amount to putting the firm into a terrible trade.

Between high valuations and sluggish growth, investors should expect disappointing returns from U.S. stocks over the next several years. Tim Hanson explains how to make more in 2010.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Berkshire Hathaway is a Motley Fool Inside Value recommendation. Berkshire Hathaway is a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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  • Report this Comment On May 04, 2010, at 8:35 PM, JVMFan wrote:

    Goldman Sachs on the Silver Screen in Financial Film

    Movie about Wall Street Corruption Screens in Hollywood and Leaves Audience in Shock

    (Hollywood, CA) Yesterday regulators fined Goldman Sachs $450,000 for violating rules governing short sales in the wake of Lehman Brothers' collapse in 2008. Not surprisingly, Hollywood was telling the story to audiences months before the SEC took action.

    "Stock Shock-The Short Selling of the American Dream," directed by Sandra Mohr, exposes the technique known as naked short selling, and explains the complicated concept to average investors using cartoons and quirky characters. In a short sale, a customer borrows a security from the brokerage, sells it in a bet the price will go down, and then buys it back later. Naked shorting involves selling short without arranging to borrow shares within the three-day settlement period. "I had no idea you could sell something you don't own," says Judy Robb after seeing the movie.

    "Stock Shock" suggests market manipulation resulted in the collapse of the stock value of some of America’s largest public companies--including Lehman Brothers and Sirius XM. Sirius XM, often listed as one of the most shorted stocks in the market, is dissected in the movie. "Stock Shock" interviews individual investors who saw their stock price hit a high of $9.00/share and then plummet to a horrifying low of 5 cents in 2009. It is often implied that hedge funds and financial giants like Goldman Sachs played a role in the downturn of the stock and the market as a whole.

    Enraged investors and fans of the movie reportedly sent their DVDs to the SEC demanding protection. Some claim "Stock Shock" has spurred a grassroots movement helping convince the agency to address the issue of abusive naked short-selling.

    The film was featured at the "Los Angeles Women's International Film Festival" at the Laemmles Sunset 5 Theaters in Hollywood in March. It looks like someone in the audience may have worked for the Securities and Exchange Commission.

    The SEC and the regulatory arm of the New York Stock Exchange found that from December 2008 to January 2009, the firm accepted and cleared 385 naked short orders.

    A Goldman spokesman said the violations resulted from a processing error, and had no financial effect on clients. They must not have seen "Stock Shock."

    Movie trailer and DVD is at

  • Report this Comment On May 04, 2010, at 11:04 PM, rd80 wrote:

    "It's very difficult to imagine a negotiated fine and related costs that would come anywhere near the reputational risk and uncertainty associated with a trial."

    It's very easy to imagine. Goldman goes on trial and wins.

  • Report this Comment On May 05, 2010, at 1:10 PM, Doris411 wrote:

    rd80, Arthur Andersen won in court. Did them a lot of good, didn't it?

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